Wednesday, April 6, 2016

The Coming Debt Denouement

While house prices and debt might continue to rise, if they do the eventual adjustment will be even more severe.

Debt is not just an Australian problem. Indeed, while many countries face significant public debt problems, Australia has considerable room to move. Given that money is virtually free at the moment now would be a good time to enhance Australia's infrastructure both physical and mental.

One of the most important variables for understanding the sustainability of debt is the debt servicing ratio. Alongside Denmark and the Netherlands, Australia has the highest ratio of the advanced economies.

Australia's ratio has declined since the global financial crisis because of the considerable lowering of interest rates. While it is unlikely that interest rates will rise anytime soon - the next move will probably be down - eventually they will rise again. This will profoundly affect the household sector and consumption if debt remains high when the RBA tightens monetary policy.

Both Denmark and the Netherlands have a higher level of household debt to income than Australia but both are deleveraging while Australian debt continues to grow. The graph below shows debt as a percentage of GDP rather than income (income is a better comparison)

It's clear that there are vested interests wanting to maintain high house prices in Australia, While it sounds heretical in the Australian context, constantly expanding house prices are not good for society as whole and for most buyers and sellers it constitutes wealth illusion.